SEC Private Funds Unit Managers Speak on SEC Exams

The Small Business Investor Alliance (SBIA) held its annual Midwest Private Equity Conference in Chicago on May 29-30, 2014. Co-sponsored by the law firm of McGuireWoods LLP, this year’s conference focused on the state of the lower middle market and on Securities and Exchange Commission (SEC) private fund examinations.

SEC examiners Matthew Harris and Bradley Kartholl − both members of the SEC’s Private Fund Exam Unit and the Private Fund Working Group, which are co-chaired by Igor Rozenblit and Marc Wyatt − discussed the Dodd-Frank Act and the SEC’s current presence examination initiatives with respect to registered private equity advisers. These examinations aim to assess issues and risks of the private equity industry. For example, to curb any misaligned incentives, the SEC examiners often will focus on:

1. the disclosure of fees, expenses and syndication costs in a private equity fund’s limited partnership agreement;
2. sufficiency of limited partners’ information rights;
3. the fund’s valuation procedures;
4. existing policies to mitigate conflicts of interest and implementation of these policies; and
5. overall compliance with the fund’s stated investment strategy.

Additionally, the SEC examiners described the process and methodology of a typical presence exam. Once an investment adviser is selected for examination, the SEC’s Private Fund Exam Unit develops a risk-based exam strategy based on relevant public documents (e.g., Form ADV, SEC Form D, state filings) and documents the SEC examiners receive through written requests to the investment adviser. The SEC Private Fund Exam Unit then conducts the on-site exam, which includes targeted interviews with the chief compliance officer and other investment professionals. The SEC examiners noted that these interviews generally are aimed at obtaining:

1. a clear understanding of the investment adviser’s business;
2. a description of key compliance risks previously identified by the investment adviser, and its strategy for resolving or mitigating these; and
3. further information around the SEC’s predetermined areas of potential risk (without the SEC examiners explicitly disclosing such risks to the investment adviser during the interviews).

The SEC examiners also noted that they find helpful, and have generally come to expect, an introductory presentation that addresses items (i) and (ii) above. Upon completion of the exam, the SEC examiners conduct an exit interview to be followed by a phone call and formal letter describing the SEC’s findings. Even if the SEC examiners do not offer to provide an exit interview, it is often advisable to request one in order to obtain an early view of any findings and begin preparing a response to the extent one is warranted.

The private equity practice group at McGuireWoods LLP is dedicated to keeping clients advised of new legislative and business developments as they occur. If you have any questions regarding SBIC Funds or SEC presence exams, please feel free to contact Mark A. Kromkowski (312.849.8170), your primary attorney at McGuireWoods LLP or any of the authors.